The Brazil Report

Crowds gathered in Chicago and Tokyo sat silent and stunned as first one city then the other was unceremoniously eliminated as the host of the 2016 Summer Olympics. With one round of voting left, Rio de Janeiro and Madrid remained.

And then cheers erupted from the multitudes gathered on Rio's famed Copacabana Beach: Rio had won by a vote of 66 to 32.

In an instant, the world's gaze turned to Brazil, which as a prelude to the Olympic Games will also host the 2014 World Cup. But what casual observers were just starting to notice was something foreign investors already knew: During the past 15 years, Brazil has transformed from a fragile economy into a major international business player.

Some of Brazil's most valuable attributes have long been clear. In sheer land mass, it ranks fifth in the world with an area of 3.3 million square miles--just behind China and ahead of the continental U.S. It's a country rich in resources, from the verdant rainforests of the Amazon to a massive, recently discovered offshore oil reserve invigorating an already robust oil and mineral trade.

While the global economy cracked under the weight of recession, Brazil suffered a downturn for only two quarters in late 2008 and early 2009. Since then, its economy has rebounded spectacularly, with anticipated growth of 7.6 percent in 2010, according to the U.N.

In 2007, Brazil's government pledged $349 billion toward domestic improvements such as water sanitation and affordable housing through the Growth Acceleration Program (PAC, based on the Portuguese spelling). In anticipation of the World Cup and Olympics, Brazil's government announced in March an additional PAC investment of $526 billion in infrastructure between 2011 and 2014, including opportunities for more than $220 billion in foreign investment.

But there are challenges that temper the excitement generated by the burgeoning economy. In a country with a cavernous divide between rich and poor, 22 percent of the population lives below poverty, according to the World Bank. Many investors complain of overregulation and a confounding tax code. And crime perpetrated by street gangs, drug lords and even the police is still rampant.

"Brazil is an interesting and exciting place to do business, but it's also a frustrating place," says Joseph Perkins, senior counsel at manufacturer Cummins Inc., which has operated in Brazil since the early 1970s. On the following pages, InsideCounsel explores the opportunities and offers guidance for navigating the challenges of doing business in Brazil.

Building a Future

As the nascent African continent slowly separated from the Americas more than 150 million years ago, crumbling rocks scattered across the floor of the Atlantic Ocean, setting the stage for one of the most pivotal discoveries in Brazil's history. Drillers found the first traces of oil in what is known as the presalt region--oil deposits that rest beneath a layer of salt under the ocean floor--along Brazil's coast in August 2005. Over the next five years it became clear that the trace of oil wasn't just a fluke; it was the siren call of a vast store of oil with the potential to double Brazil's reserves.

"The amount of investment and the impact the [presalt oil] will have on the local economy is huge," says Marcos Chaves Ladeira, a partner at Pinheiro Neto Advogados. Energy giant Petrobras, Brazil's largest company, estimates the presalt fields hold between 10.6 and 16 billion barrels of high-quality oil, though some analysts project Brazil can recover as many as
50 billion barrels.

To maximize the profits from the presalt reserves, however, Brazil will need to make quick, dramatic changes to its fragmented infrastructure, which has plagued business development in the nation for decades.

"Infrastructure bottlenecks are perhaps one of the main, if not the most, significant factor that has deterred the kind of growth Brazil could have had over the past 15 years," says Robson Barreto, president of the American Chamber of Commerce of Rio de Janeiro and a partner at Veirano Advogados. Because the government has lagged in establishing reliable highways, ports and railways, he says that many companies resort to creating their own transport chain.

Since his election in 2002, Brazilian President Luiz In?cio Lula da Silva has prioritized infrastructure enhancements. In 2007, Lula announced the National Development Agenda, which aims to transform Brazil from an emerging economy to a fully developed nation by 2022 and hinges significantly on infrastructure improvements.

The Growth Acceleration Program (PAC, based on the Portuguese spelling) gives companies tax credits for investing in the national infrastructure, a valuable benefit in a country with a notoriously burdensome tax code. The first phase focused on energy and urban planning. The second phase, which is set to run from 2011 to 2014, will further bolster energy but will also target civil construction and transportation--crucial developments with the looming deadline of the World Cup in 2014, followed by the Olympics in 2016. In Rio alone, the foreign investment opportunities total more than $10 billion, according to the Consulate General of Brazil in Chicago.

Foreign companies with an established presence in Brazil have already started to feel PAC's impact. Cummins Inc. Senior Counsel Joseph Perkins, who is responsible for the company's legal matters in Latin America, says its business has grown in proportion to Brazil's own economic growth over the past few decades. Now much of Cummins' customer base is taking advantage of PAC, leading to a trickle-down benefit for the manufacturer.

"PAC has benefitted markets we don't directly participate in, but our customers do," Perkins says. "We make products that support the oil and gas business, for example. The same thing can be said for mining. The same thing can be said for construction. The indirect impact can be very big."

Taxing Regulations

While its economy is flourishing, Brazil's complicated regulatory framework can be tricky for foreign companies to navigate. "It's a very nice jurisdiction to invest in, but it's clearly not for beginners," Barreto says.

Rather than functioning on a common law system like the U.S., Brazil relies on a Napoleonic framework of codes, the most notorious of which governs taxes. More than 75 percent of firms in Brazil say that tax administration is a major business constraint, according to Enterprise Surveys. Across all countries surveyed, only 23 percent of firms say taxes are a major constraint.

Brazil's tax code comprises roughly 50 individual elements, though Barreto says only about a dozen cause any significant financial impact. At about 34 percent, the corporate tax rate mirrors that of the U.S., which can reach 35 percent. The bigger cost comes from the man hours required to ensure compliance with all the components.

Across the board, experts agree that it's critical for foreign companies to retain local counsel that have an ingrained knowledge of the tax code. Perkins also suggests becoming familiar with the specific taxes that affect the individual business.

"Know enough to advise the company on the things it needs to watch out for and plan what it should do on the front end," he says.

Maria Green, deputy general counsel and assistant secretary at Illinois Tool Works Inc., says some elements can actually favor companies if counsel thoroughly understand the code. ITW has acquired numerous companies in Brazil during the past two decades, and Green says it retains an outside firm to perform a full tax audit on every new acquisition, which can uncover places where ITW can legally pay a lower tax rate.

It's also crucial to examine not only how the company will enter a deal but also how it plans to exit, says Gabriela Falcao Vieira, a partner at Machado Meyer. The right structure can minimize the tax impact.

"The returns can be very high compared to other investments abroad," she says. "Make that investment worth it."

The lengthy, inflexible labor code also causes headaches for in-house counsel. Whether it's overtime pay, rules for hiring and firing, or vacation time, the code's got it covered. As Ladeira puts it, "You don't have to say anything in [your company's] labor contract because it's all in the law."

Labor disputes are common and have a reputation for clogging up the already overburdened courts. Barreto says it's not unusual for 10 percent of a company's workforce to be embroiled in pending labor claims. Litigation, regardless the matter, typically takes about a decade to resolve. Perkins attributes the glacial pace to limited opportunities for alternative dispute resolution. Brazilian courts also don't rely on precedents when deciding cases, so there are few hints as to the direction a particular case will take.

Both Green and Perkins say their companies have a backlog of labor cases winding their way through the Brazilian system. Two years ago Brazil created a court specifically for labor cases, but Perkins says it's had little impact. "Now you just have a parallel court system that's just as jammed," he says.

True Crime

Much of the buzz surrounding Rio's Olympic bid focused on the city's criminal activity. Though efforts to clean up some of Rio's more dangerous neighborhoods have found some success in recent years, both crime and corruption are still very real issues throughout Brazil. As the "Lonely Planet" travel guide for Brazil bluntly says, "Accept the fact that you might be mugged, pickpocketed or have your bag snatched while you're in the country."

For companies such as Cummins Inc., Perkins says that means implementing solid onsite security, including controlled access to the property and secure transportation of goods through the supply chain.

But government corruption remains an issue, with Foreign Corrupt Practices Act (FCPA) violations a fairly common concern. Green says ITW has been approached to make illegal payments to receive a favorable outcome for litigation, offers she says the company absolutely declined. From a Brazilian standpoint, paying bribes to get permits or bypass some aspects of the complicated regulatory structure might not be illegal, Steiger says, but the U.S. absolutely considers it criminal activity.

As a result of overregulation, Brazil's underground economy flourishes, Steiger says. In-house counsel therefore can't rely solely on public records to assess the legality of business opportunities. Steiger suggests putting together a trustworthy indigenous team to thoroughly vet investment opportunities and ensure their legitimacy before the company makes a commitment.

"In some cases, companies are cutting back on due diligence efforts," he says. "But diligence is the last place on earth where you should cut back to save a few thousand dollars. Put boots on the ground. See the area. Meet the people. And make sure partnerships are the right ones."

Foreign companies often hire a despechant--which translates to middleman--to help navigate Brazil's regulatory requirements. But Steiger cautions that in-house counsel must carefully evaluate anyone who fulfills that role.

"If you're getting someone you don't have confidence in, you could be buying more trouble than it's worth," he says. He suggests getting recommendations from the U.S. Chamber of Commerce in Brazil.

Looking Ahead

Though it's an election year in Brazil, analysts expect the positive momentum in its economy to continue uninterrupted. The country will elect its new president Oct. 3, just as this story arrives in mailboxes.

Lula's former chief of staff, Dilma Rousseff, is favored to succeed him. A member of Brazil's Workers' Party, her policies mirror many of Lula's own. If Rousseff wins, the PAC program will most certainly continue, Perkins says, as she played a major role in drafting it. Regardless, the opportunities for foreign investment are likely to continue.

"All of the infrastructure improvements of the PAC program need to be done to prepare Brazil to host the world in two big global events," Perkins says. "There would have to be some other way to get things done."

And if Brazil continues to meet its National Development goals, the economy will continue to grow at a rate of at least 6 percent through 2022.

"Even though it is a stable economy, it is a growing economy," Vieira says. "It still has space, and the opportunities for investment are huge."